Question

The -Select-shorterlongerCorrect 3 of Item 1  a project's payback, the better the project is. However, payback has 3 main disadvantages: (1) All dollars received in different years are given -Select-lessequalmoreCorrect 4 of Item 1  weight. (2) Cash flows beyond the payback year are ignored. (3) The payback merely indicates when a project's investment will be recovered. There is no necessary relationship between a given payback and investor wealth maximization.

A variant of the regular payback is the discounted payback. Unlike regular payback, the discounted payback considers -Select-projectcapitaloverheadCorrect 5 of Item 1  costs. However, the discounted payback still disregards cash flows -Select-duringbeforebeyondCorrect 6 of Item 1  the payback year. In addition, there is no specific payback rule to justify project acceptance. Both methods provide information about -Select-profitabilitywealthliquidityCorrect 7 of Item 1  and risk.

Quantitative Problem: Bellinger Industries is considering two projects for inclusion in its capital budget, and you have been asked to do the analysis. Both projects' after-tax cash flows are shown on the time line below. Depreciation, salvage values, net operating working capital requirements, and tax effects are all included in these cash flows. Both projects have 4-year lives, and they have risk characteristics similar to the firm's average project. Bellinger's WACC is 10%.

	0		1		2		3		4
Project A	-1,200		650		445		260		310
Project B	-1,200		250		380		410		760

What is Project A's payback? Round your answer to four decimal places. Do not round your intermediate calculations.

  years

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Correct

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Review the payback definition.

The solution for payback is a number not a percentage rate or dollar value.

The payback calculation is not dependent on the firm's WACC.

Don't forget the minus sign for the Year 0 cash flow.

What is Project A's discounted payback? Round your answer to four decimal places. Do not round your intermediate calculations.

  years

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Incorrect

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Review the discounted payback definition.

The solution for discounted payback is a number not a percentage rate or dollar value.

The discounted payback calculation is dependent on the firm's WACC.

Don't forget the minus sign for the Year 0 cash flow.

What is Project B's payback? Round your answer to four decimal places. Do not round your intermediate calculations.

  years

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Correct

Check My Work Feedback

Review the payback definition.

The solution for payback is a number not a percentage rate or dollar value.

The payback calculation is not dependent on the firm's WACC.

Don't forget the minus sign for the Year 0 cash flow.

What is Project B's discounted payback? Round your answer to four decimal places. Do not round your intermediate calculations.

Answer 1

The shorter a project's payback, the better the project is. However, payback has 3 main disadvantages: (1) All dollars received in different years are given equal weight. (2) Cash flows beyond the payback year are ignored. (3) The payback merely indicates when a project's investment will be recovered. There is no necessary relationship between a given payback and investor wealth maximization.

A variant of the regular payback is the discounted payback. Unlike regular payback, the discounted payback considers capital costs. However, the discounted payback still disregards cash flows beyond the payback year. In addition, there is no specific payback rule to justify project acceptance. Both methods provide information about liquidity and risk.

What is Project A's payback?
=2+(1200-650-445)/260=2.403846154

What is Project A's discounted payback?
=3+(1200-650/1.1-445/1.1^2-260/1.1^3)/(310/1.1^4)=3.21716129

What is Project B's payback?
=3+(1200-250-380-410)/760=3.210526316

What is Project B's discounted payback?
=3+(1200-250/1.1-380/1.1^2-410/1.1^3)/(760/1.1^4)=3.675486842